Implementing the Buy-Sell Agreement in a Closely-Held Business

There are owners of closely-held businesses who become disabled or must terminate their employment at the business and fail to realize a meaningful value for their business interest. There are owners, not holding a controlling interest, who will have nothing to say about the outcome of certain business transactions or their departure from the business. There are owners, failing to recruit new owners, who have no one to buy their business at their death. There are owners, failing to extricate themselves from management, who demean the value received for the business because they are an essential part of the business and can no longer be involved to insure profitability. There are many and all varieties of examples of owners not receiving maximum value from their business interest. All of these owners should have implemented a buy-sell agreement in their closely-held business to have received maximum value for their business interest.

Most businesses do not have a buy-sell agreement among the owners because it is quite difficult to negotiate a buy-sell agreement between the owners of a closely-held business. Often the subject matter is difficult to discuss, and the pressures of operating an owner-managed business make it difficult to find the time needed to accomplish this task. As with most complex and difficult tasks, it is best to use a segmented approach and address the various issues one at a time.

The issues that must be discussed and agreed upon can be generally described. The business entity type of the business should be understood in terms of liability and tax consequences for each owner. The group of individuals or entities that own the business should be defined and appropriate restrictions put in place. The governance of the business, including who will make policy and who will be the chief executive, should be clearly defined. The events (triggers) that will cause one or more owners to transfer interests in the business should be defined. The procedure of the transaction occurring after each type of trigger, including funding and payment, should be provided for in detail. For each transaction, the price of the interest transferred should be defined. If the business will act as a buyer in certain procedures, then the means of the business accumulating the funds for the transaction should be provided for in detail. The final task is the consolidation of the decisions into one coherent written document.

There should be a meeting of the owners and appropriate stakeholders to discuss each one of these general issues. For each issue there should be a separate meeting. The meetings should be held at regular intervals. The results of the meetings must be documented in writing. Where issues are technical or outside resources would be helpful, they should be utilized. The documented agreements resulting from these discussions as consolidated into one coherent document will constitute a succession plan.

The succession plan is the basis for the drafting of the buy-sell agreement, a written, legally-enforceable document. Even though there is a written plan to which the owners have agreed, each owner must have separate counsel to review and advise each owner concerning the buy-sell agreement. The exercise of creating the plan will save legal fees overall, but that agreement cannot remove the necessity of each owner reviewing the buy-sell agreement with that owner’s lawyer with the perspective of the best interests of that owner as the primary concern.

There are three general phases in the life-cycle of an owner-managed or closely-held business. The first phase is the startup, where the value of the entity is initiated. The second phase is continued profitability, where the business stabilizes, earns a profit, and the owner changes from a producer to a manager. The third phase is where the owner participates only in policy-making and hires management. In the third phase the owner will receive highest value for the business interest because the owner’s participation in the business will not be a requirement for the business’s continued profitability. An implemented buy-sell agreement can contemplate and assure the transactions necessary to attain the third phase of the business life cycle. Moreover, if the inevitable transfer of the owner’s interest happens before the third phase, an implemented buy-sell agreement will provide value for that interest that will be more than would be otherwise received.

Although it is difficult to implement, the buy-sell agreement will provide maximum value for a hard-earned business interest.